Working capital

Working capital is current assets minus current liabilities — the liquidity a business needs to run day to day. In an M&A deal it is not just an accounting concept: it is a negotiating point that determines whether the buyer receives a business with enough cash and receivables to operate from day one, or one drained before closing. In Mexican SME deals, working capital adjustments are one of the most common sources of price renegotiation after the LOI — and one of the least understood by sellers.

How do you calculate working capital?

Current assets include:

• Cash and banks
• Accounts receivable
• Inventory
• Prepaid expenses

Current liabilities include:

• Accounts payable
• Accrued expenses
• Short‑term debt
• Deferred revenue

Why does working capital matter in an M&A deal?

• The adjustment mechanism at closing. Most M&A deals include a target working capital — a normalized level the seller must deliver at closing. If actual working capital at closing is below target, the purchase price is reduced peso for peso. If it is above, the seller can receive additional consideration. In Mexican SME deals this mechanism is missing from many LOIs but appears in the definitive agreement — surprising sellers who did not anticipate it.
• Pre‑closing drain risk. Between LOI signing and closing, a seller who speeds up collections, delays payments to suppliers, or cuts inventory is pulling working capital out before transfer. Buyers protect themselves with working capital covenants in the definitive agreement — requiring the seller to operate in the ordinary course between LOI and closing. For the full process context, see stages of the M&A process.
• Working capital in seasonal businesses. In businesses with seasonal revenue — agriculture, retail, construction — working capital varies a lot by month. Target working capital should be set from a normalized average, not the snapshot on closing day. A seller who closes in a low‑season month with naturally low receivables can face a working capital shortfall adjustment that reflects seasonality, not poor management.

Illustrative example, consumer goods distribution, Mexico 2024: a distributor signed an LOI; the definitive agreement set target working capital based on a normalized average. At closing actual working capital was lower — the seller had collected aggressively and delayed supplier payments. The buyer invoked the adjustment clause.

The seller had not understood that the LOI price assumed delivery of normalized working capital.

Working capital is not an accounting detail — it is part of the price. A seller who drains the business before closing does not walk away with more money: they walk away with less, plus a penalty.

What is the difference between normalized and reported working capital?

In M&A, target working capital in the definitive agreement is based on normalized working capital, not the closing‑day snapshot. The adjustment mechanism compares actual at closing to target and adjusts price accordingly. A seller who does not understand this distinction will be surprised by a closing price cut that was agreed contractually months earlier. The concept is parallel to normalizing earnings: see Normalized EBITDA.

What do buyers and sellers ask about working capital in M&A?

Is working capital part of Enterprise Value?

No. EV is calculated independently of working capital. Target working capital is a separate mechanism that adjusts consideration at closing so the buyer receives the business with enough liquidity to operate. Think of it this way: EV buys the earnings capacity of the business; the working capital adjustment ensures the operating tank is full at delivery.

How is target working capital defined in a deal?

It is negotiated in the definitive agreement based on a normalized 12‑month historical average (seasonality and one‑off items adjusted). The seller should propose the methodology during LOI negotiation — not wait for the buyer’s lawyers to define it in the definitive agreement. A methodology proposed by the seller using a favorable historical period is easier to defend at LOI stage than at definitive agreement stage.

What if the seller delivers more working capital than the target?

If actual working capital at closing exceeds the target, the seller receives additional consideration equal to the excess — a working capital true‑up in their favor. Less common than the downward adjustment but symmetric: the mechanism works both ways. A seller who builds receivables and inventory above target before closing effectively increases their consideration.

Do Mexican SME deals always have a working capital adjustment?

Not always — many LOIs and definitive agreements for Mexican SMEs omit the working capital adjustment entirely, especially in smaller deals or asset purchases where the buyer acquires specific assets rather than a going concern. But omitting it does not remove the risk: a buyer who receives a business with thin receivables and payables at the ceiling has effectively paid more than the agreed EV. The absence of a formal adjustment shifts risk to the buyer — which is why sophisticated buyers insist on including it even in smaller deals.